M.B.

MOHAMED YAZAR
IIBI/PGD/1932/10
98, MOSQUE ROAD.
DALKOTUWA
WELAMBODA.
SRI LANKA
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Answers for..

Islamic Economics &

Finance
Module -03
Lesson 01:

Outline of the Conventional Banking System

Tutor: Muhammad Nasir

Lesson 01, Question 01
We can describe the commercial bank as, an instituton which offers related services.
Commercial banks also allow for a variety of deposit accounts, such as checking, savings, and
time deposit. The main objective of commercial banks are profit maximization of its
shareholders through facilitating the business by borrowing from public and lending business
firms and individuals as the based on interest.

We can classify the functions of commercial banks as follow

(1) Primary functions

(2) And secondary functions

The primary functions of commercial banks are as follows:

(1) Accepting deposits of money:

The most important function of the commercial bank is to accept deposits from the public.
A bank provides interest on all types of deposits and the public feel secured when their
money is with the bank. People deposit their money in the form of Savings account, current
account, fixed deposits and Recurring deposits. The interest provided by the bank is known
as borrowing rate.

(2) Advancing loans:

Another important function of commercial banks are, to make loans and advances to the
needy people. The loans may be in the form of call loans, over draft, cash credit, term loan
and discounting of bills. It charges higher rate of interest for these loan. The interest
charged by the bank for its lending is known as lending grate.

(3) Transfer of deposit:

This is the most important function of a commercial bank. A bank has to transfer money of
the depositor when demanded by them. Money can be transferred from one account to
another account of the same person, or from one place to another, from one person to
another. This can be done by the customer by using checks.

(4) Permitting withdrawals of money

Bank allows the depositors to withdraw either the entire or a part of it by using withdrawal
slips checks, ATM cards etc. These withdrawals are allowed as per certain conditions of the
bank for certain accounts.
 (05) Credit creation

It is most significant function of the commercial banks. While sanctioning a loan to a

customer, a bank does not provide cash to the borrower Instead it opens a deposit account
from where the borrower can withdraw. In other words while sanctioning a loan a bank
automatically creates deposits. This is known as a credit creation from commercial bank.

Secondary Functions of Commercial Banks are as follows:

Along with the primary functions commercial bank are perform several secondary functions
too. It includes many agency functions or general utility functions. The secondary functions of
commercial banks can be divided into agency functions and utility functions.

The banks provide various agency Functions such collect and clear cheqeus, providing bank
guarantees and letter of credit, make payment of rent, insurance premium, deal in foreign
exchange transactions, to purchase and sell securities, to act as trusty, attorney, correspondent
and executor.

The general utility functions of the commercial banks include, to provide safety locker facility to
customers, provide money transfer facility, issue traveler’s cheque, act as referees, accept
various bills for payment such phone bills, gas bills, water bills, provide merchant banking
facility, provide various cards such as credit cards, debit cards, Smart cards, etc.

For all above services, banks charge considerable amount from client or merchants as service
fee.

Lesson 01, Question 03

Functions of Central Banks

A central bank, is a public institution that usually issues the currency, regulates the money
supply, and controls the interest rates in a country. Central banks often also oversee the
commercial banking system within its country's borders. A central bank is distinguished from a
normal commercial bank because it has a monopoly on creating the currency of that nation,
which is usually that nation's legal tender.

The primary function of a central bank is to provide the nation's money supply, but more active
duties include controlling interest rates and acting as a lender of last resort to the banking
sector during times of financial crisis. It may also have supervisory powers, to ensure that banks
and other financial institutions do not behave recklessly or fraudulently.
Following are basic functions of central banks

- implementing monetary policy

- determining Interest rates
- controlling the nation's entire money supply
- the Government's banker and the bankers' bank ("lender of last resort")
- managing the country's foreign exchange and gold reserves and the Government's stock
register
- regulating and supervising the banking industry
- setting the official interest rate – used to manage both inflation and the country's
exchange rate – and ensuring that this rate takes effect via a variety of policy
mechanisms

Banking supervision

Central banks control and monitor the country’s banking industry directly or through its
subsidiaries. Its vary from country to country. In some countries banking supervision is carried
out by a government department, for example in uk by UK Treasury, or an independent
government department ( for example UK’s Financial Services Authority).It examines the banks'
balance sheets and behavior and policies toward consumers. Apart from refinancing, it also
provides banks with services such as transfer of funds, bank notes and coins or foreign
currency. And central banks defined as “bank of banks".

Money creation by central banks

Central banks has the power to control money supply in the country. When the commercial
banks deposit their money in central banks, its become as liability to the central banks and
increase the supply of money in to the economy. since the commercial banks will have a larger
amount of cash reserved at the central bank on which they can apply leverage by granting loans
to their customers, as long as they themselves maintain the stipulated legal cash reserve
requirement. As we discussed above central banks are act as the banker of the government and
has more freedom to create money against government. Government may borrow money from
central banks and supply to the economy to fulfill its obligation by issuing cheqes. And at last it
will deposited to commercial banks. Its cause to increase deposit in their banks and they able to
grant loan for firms and its customers. Therefore, the central banks have the power to increase
or decrease the quantity of money available to the public by increasing or decreasing the
availability of money to the commercial banks.

Central banks must be very careful to balance the money supply in nations, because the
creation of “reserve currency” can cause to international financial market. However the
excessive creation of money cause to inflation and exchange rate, and too little precipitate can
cause to economic crash.
Sources:
IIBI-PGD,Module3-Lesson1
Wikipedia\functions of central banks